Boutique dealers still struggling: IIAC

At this point, the IIAC only has complete data for the first nine months of 2013, but extrapolating those numbers until the end of the year, it projects a significant jump in total operating profits. Moreover, it notes that its estimates are likely conservative, given that the wealth management business was bolstered by strong equity markets in the last quarter of 2013.

The big firms continue to account for the lion’s share of the industry’s profits, the IIAC estimates their collective profits at almost $3.9 billion, up about 20% from 2012. Institutional firms actually saw a stronger rise in profits, up an estimated 33.5% to over $800 million. And, while pure retail firms only brought in about $150 million in profits, this represents a turnaround from the previous year, when they recorded negative operating profits of $18 million.

However, the IIAC says that, over the past five years, the industry has generally seen relatively strong earnings at the large firms, and weak results among the boutiques. It reports that profits for integrated firms rose on average 43% in the last five years, while they declined by 39% in the retail segment, and dropped 67% for domestic institutional boutiques, over the same period.

“The sustained divergence in performance across the firm groupings has triggered a complementary shift in the allocation of shareholder equity,” it notes, with capital flowing into the large firms, and away from the boutiques, over the past few years. And, it expects this to continue this year “from continued losses at the institutional firms, additional firm closures and possible acquisitions of retail firms.”

Looking ahead, the IIAC notes that, while the securities industry has been anticipating an improvement in market conditions to help boost earnings, it may be disappointed. “The reality is that the industry will likely face further challenges this year and next, from continued weakness in small business resource markets, and from stiff competition from the integrated firms in the wealth management business, as well as from the exempt market dealers in arranging financings for small business,” it says.

Next: Exempt market competition
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Exempt market competition

The report suggests that investment banking revenues for the institutional boutiques could continue to slide, driving further structural change. “In this environment, the institutional boutique sector will continue to retrench through consolidation, closure and migration of registration to the exempt dealer regime, restricting their business to accredited investors and institutions,” it says.

Indeed, the IIAC notes that the exempt market dealers (EMDs) have emerged as a strong competition in the business of raising capital for small resource companies. It maintains that there’s an unlevel playing field between investment dealers and EMDs, which benefit from a lower regulatory burden.

It notes that the Canadian Securities Administrators (CSA) are adopting reforms, such as the Client Relationship Model (CRM) reforms, that should redress some of that imbalance; but, it questions the ability of the CSA to effectively oversee the large crop of EMDs. And, it supports the CSA’s proposal for a new prospectus exemption (the so-called existing shareholder exemption) as a way to ease the cost for junior issuers to raise capital from existing retail shareholders.

On the retail side, the IIAC reports that retail revenues have risen significantly at the integrated firms over the past four years, outpacing the retail boutiques, where revenue “remains well below 2011 levels”.

It notes that the disparity in revenue growth is partly due to the bank-owned dealers’ acquisitions of independent firms. And, at the same time, strong gains in fee revenue at the integrated firms, which is up 46% over the past five years, accounts for the difference in earnings performance between the big firms and the retail boutiques.

“The rapid growth in fee income, in absolute terms and as a share of retail revenue, reflects the expanding client shift to discretionary managed accounts and the offerings of specialized services, such as tax and estate planning for aging clients,” it says.

At the same time, the integrated dealers have seen costs rise significantly, due in part, it says, to spending on the retail side to meet the rising demands from clients, as they age. Among the boutiques, operating costs have not risen as much, it notes; as they don’t have the resources to spend in order to keep up with the offerings of the integrated firms.

Nevertheless, the IIAC suggests that boutique firms “have an important niche business opportunity offering customized wealth management services to [smaller] clients.” It says that clients with portfolios of less than $100,000 “typically fall under the radar screen of the integrated firms”. And, it suggests that the boutique dealers can exploit this opportunity, by seeking “significant business from clients in the mass-market channel dealing with financial planners.”